The impact of efficiency on asset quality in banking

Badunenko, Oleg; Dadoukis, Aristeidis; Fusi, Giulia; Simper, Richard

Abstract

We investigate the impact of banks’ ability to minimise costs on asset quality, by assessing the temporal relationship between these variables in a sample of Italian banks over the period 2006–2015. We offer new insights into the channels through which bank efficiency affects non-performing loans by disentangling the short-term component of cost efficiency from its long-term component. We show that non-performing loans afflicting Italian banks can be explained by both efficiency components. A decrease in short-term cost efficiency precedes a worsening in banks’ asset quality, implying that regulators should consider adopting short-term efficiency as an early warning indicator of a deterioration in asset quality. We also present evidence of a trade-off between long-term efficiency and bank non-performing loans, which suggests that the removal of exogenous hindrances that prevent banks from allocating optimal levels of resources to the management of their loan portfolio should be a main policymakers’ objective.

Citation

Badunenko, O., Dadoukis, A., Fusi, G., & Simper, R. (2022). The impact of efficiency on asset quality in banking. European Journal of Finance, 28(6), 596-620. https://doi.org/10.1080/1351847X.2021.1946117

• Journal Article Type: Article
• Acceptance Date: Jun 7, 2021
• Online Publication Date: Aug 15, 2021
• Publication Date: 2022
• Deposit Date: Jun 9, 2021
• Publicly Available Date: Feb 16, 2023
• Journal: European Journal of Finance
• Print ISSN: 1351-847X
• Electronic ISSN: 1466-4364
• Publisher: Informa UK Limited
• Peer Reviewed: Peer Reviewed
• Volume: 28
• Issue: 6
• Pages: 596-620
• DOI: https://doi.org/10.1080/1351847X.2021.1946117
• Keywords: Economics, Econometrics and Finance (miscellaneous); Banking; Non-performing Loans; Stochastic Frontier Analysis; Short-term Cost Efficiency; Long-term Cost Efficiency JEL Classifications: C33; G01; G18; G21; G28
• Public URL: https://nottingham-repository.worktribe.com/output/5653041
• Publisher URL: https://www.tandfonline.com/doi/full/10.1080/1351847X.2021.1946117